Contract Surety Bonds and the Small Business Administration

Ever wonder what a Surety Bond is exactly?

Surety bonds are required in many instances where a contractor or service company enters a contract to perform specific work. The bond is a financial obligation issued in your behalf by a surety company (who are also most often an insurance company) to guaranty the completion of the contract or service agreement. The bond can be invoked by the entity to which it is provided in the event the contract or service is not completed as required, or there is an act of default by the contractor. The Obligee is the entity with who the contract is entered and to whom the bond is provided. If the contractor (called the Principal on the bond), does not complete the contract or service obligation according to the Obligee’s specifications and according to the terms of the contract, and once all other methods of remedy have been exhausted, the surety Company will step into the role of the contractor. That may involve locating another contractor to finish the job, and/or making a money payment to the Obligee so the contract or service can be completed as required.

In the common language of surety bonds, there are some ABCs to remember for the most commonly used type of bonds:

A. Performance Bond: Issued to the Obligee in behalf of the Principal to guaranty completions of a contract for construction or for services.

B. Payment Bond: This is most often issued along with the Performance Bond. The Payment Bond is written and given to the Obligee so they have a level of assurance you will make necessary payments for labor and supplies used on the project. Failure to do so can create liens and lawsuits against the Obligee, and please be assured that is the last thing anyone wants to occur.

C. Bid Bond: This is a bond included when you submit a bid to ensure the Principal (that’s you) performs by entering into the contract, should you be awarded the bid. It also is a guaranty that, upon final underwriting by the surety company, the required performance and payment bonds will be issued to the Obligee when the contract is awarded.

How does the SBA get involved in this process?

Let’s face it. With the economic decline in the past 6 years that has impacted most everyone in construction or service related industries, it can be very difficult for to qualify for a surety bond. The underwriting involved with qualifying for bonding can be rigorous. There is a lot of financial information about your construction or service company and its owners that needs to be disclosed. It is very much like going to a bank and applying for credit. And we all know how much of a task that can be! The role of the Office of Surety Guarantees (called SBG) is that of issuing, upon underwriting qualification, a formal surety bond guaranty. This is done through participation with qualified surety companies and surety agencies, like Bonding Solutions, LLC. The SBA guaranty is there as a tool to help the surety company fill the gaps in those instances where a contractor does not qualify under a standard bond underwriters’ approval. With the SBA’s guaranty, most often it will help you obtain the bond thereby allowing you to bid a project, or bond it according to the terms of the contract. Without the bond in place, your bid will not be accepted, and/or you will not be awarded the contract. So you can see from that perspective how useful the SBG becomes.

Recent changes to the SBG has set generous limits to help in ensuring a contractor or service provider has adequate bonding capacity to go after the jobs they want. We have seen payment and performance and bid surety bonds issued as much as $6.5 million. If you are bidding a Federally funded project and the contracting office will certify it, we can offer bonds in those instances up to $10 million through the SBG. That can be a sizable job for a well-qualified small business!

So what’s this all going to cost?

Well, of course there are fees and expenses for obtaining an SBG, but they are a fairly small percentage of the overall project. Really, they are less than 1% of the total cost of the construction or service contract. As a small business, the cost for the SBG is 0.729% (or $7.29 for every $1,000 of contract amount) of the value of the contract awarded. And that is an important distinction to keep in mind. The cost of the bond is always based on the value of the contract, even though the contract will occasionally specify a bond amount less than the total of the contract. In those instances, the exposure to the surety company and the SBA for its guaranty is the entire contract value, not just the bond amount. Thereby, the cost will be based on that.

The costs for the payment and performance bonds charged by the issuing surety company can vary greatly depending on your qualifications as underwritten, and the type, location, and conditions of the project being completed. A good general guideline (and there is a lot of room to move up or down within this guideline) is anywhere from 1.5% to 4% of the total contract value. That is in addition to the SBG costs, and is payable to Bonding Solutions, LLC at the time the bonds are issued. As agent for the surety bond companies, we then pay them for their cost of issuing the bonds, and yes, we do keep a little commission for our services as your surety bond agent.

And while generally the old adage is that “nothing is free”, we can tell you with certainty and a straight face that in the instance of a bid bond requirement, the SBA charges you Zip—Nada—Nothing! Good news, huh? Now that’s not to say that the bid bond is completely at no cost. For the time and effort as your surety agent in submitting your application to the SBA and the various surety companies we represent, Bonding Solutions, LLC assess a fee of $100 annually. Now that seems pretty reasonable to us, considering that covers all your bid bonds for an entire 12 months!

And while we’re on the subject of costs, here’s some of information to keep in mind that we find far too many small contractors without a lot of experience in bonded contracts simply are not aware of. In the situation where you bid or are awarded a contract and the Obligee requires a surety bond, the cost of that bond in almost all instances is born by the Obligee. They are the ones imposing that requirement as a condition of the contract. So just like any other costs that are incurred to complete the job, they will be obligated pay that cost as a line item in the budget, or paid separate from the contract (which does happen from time-to-time). Please remember that in almost every instance, you as the contractor or service provider will not be required to cover that cost of the bond from your overhead/profit.

When would you need a surety bond?

You will need a surety bond for any contract you are awarded, or bid you submit, where a bond is required. That requirement will be clearly specified in the contract or the bid proposal. Any Federal construction contract valued at $150,000 or more requires a surety bond when bidding, or as a condition of contract award. The overwhelming majority of local (towns, cities, counties, districts, etc.) and U.S. state governments, as well as a whole bunch of private entities throughout the country, will specify surety bonding requirements for construction and service type contracts. Plus, there are instances where as a supplier of goods or materials that a surety bond, called a supply or materials bond, will be necessary.

How do you find out if you qualify through the SBG program offered by the SBA?

As mentioned above, there is a good deal of financial disclosure and information needed to determine a contractor’s or service provider’s qualifications for surety bonds. We will always require at a minimum the following:

1. 3 years of company financial statements consisting of a balance sheet and profit & loss statement2. Verification of company assets normally in the form of bank account statements, accounts receivable schedules, work-in-progress schedules, inventory/equipment listings, and the like.3. A personal financial statement for each owner of the company including assets and debts held jointly with a spouse4. A copy of the contract or bid proposal to be bonded5. A copy of the specific bond forms to be used as required by the Obligee6. Verification of any available bank credit lines or revolving credit facilities in the name of the company7. A recent history of jobs completed similar in size and scope to the one to be bonded, with contact information to verify those jobs8. A back-ground questionnaire on your company about who the owners and key officers are, how long the company has been in business, who the company’s banker and CPA are, and credit history information about the company and its owners

Like we said, the process is similar to that of applying to a bank for credit in the company name.

That is unless the contract or bid is for less than $250,000. In that case, the SBA offers a SBG with minimal information. Basically all we have to get is a few SBG forms filled out by you, a copy of the contract of bid proposal, owner’s personal financial statements, and copies of bond forms required by the Obligee. And that process is also streamlined with the bond company underwriters. They don’t require much more than the same abbreviated information.

Once we have all that documentation together, as your surety bond agent, we will submit the bond request to as many of the surety bond companies as needed for full evaluation. At that point, if we receive an approval for a surety bond underwriter for bond approval conditioned on and SBG, then we will go through the process of submitting the request to the SBA. Please keep in mind this can be a process of several days when you plan for a bid or finalization of a contract.

While in general, most contractors or service providers, and the contracts they enter will qualify for surety bonds assuming approval by a surety underwriter, there are some classes of business and contracts that an SBG simply is not available. Those are as follows:

1. Contract with wording to the effect that would keep the surety company from completing the contract upon default by the contractor2. Any form of a stand-alone maintenance bond3. The various types of permit and license bonds4. A class of surety bonds called Subdivision Bonds5. Bonds that guaranty a lease such as mineral extraction, or oil and natural gas6. Any bond deemed as a financial guarantee bond7. Those bonds that are a long tern warranty of a specific efficiency or performance8. Fidelity or dishonesty or theft/crime bonds 9. Bonds for the purpose of lien releases or lien guaranty10. Advance Payment Bonds11. Bonds issued specifically for completion12. Most form of mining reclamation bonds13. Performance or payment bonds greater than the contract amount unless for a demolition contract14. Bid bonds for jobs previously bid and accepted by the Obligee15. Those rare instances where a given surety company is bonding both eh sub-contractors and the prime contractor on a construction project

It would be our pleasure (and a good tool to add to your “tool-box”) for us to evaluate the qualifications of your company for a surety bond program. And with the participation of the SBA, the opportunities are promising. So please contact us for more information in contacting us to speak with an SBA Surety Bond Guaranty Specialist.